15 posts from May 2008

May 06, 2008

Rich worries that giving investors stakes in home values will lead to a cascade of damaging consequences: exclusionary zoning, racial segregation, and the perpetuation and privileging of homogeneous white suburban enclaves.Such consequences might come about either through investor pressures on the local political process or through private business practices such as "redlining." These are serious concerns, and ones that I share.However, I think H2.0 would lead to fewer of these problems than the present homeowner-driven system of local control.

First, investors are likely to be better bearers of risk than the homeowners who would choose H2.0.Not only are investors likely to be more diversified, they will have affirmatively self-selected into the investment rather than falling into it simply because they wanted to own a home.As Bill Fischel has argued in The Homevoter Hypothesis, homeowners tend to be extremely risk averse about their home values, given the importance of the home in their portfolios, and they vote accordingly.They may, therefore, oppose changes that actually have positive expected values, simply because they are unable to bear any significant variance in outcomes.Second, the fact that investors are often at a remove from the neighborhood (both physically and emotionally) may make them less likely to be swayed by inflammatory rhetoric about the purportedly negative impacts of what are in fact benign or beneficial land use proposals.Third, investors are more likely than individual homeowners to hold offsetting interests in other properties or entities, including those in neighboring localities.Having a stake in many communities rather than just one is likely to rein in the NIMBY impulse to push externalities onto outsiders.

Of course, it would be unrealistic to imagine that self-interest alone will always cause investors to act in socially optimal ways. Law will need to play a role. Just as discriminatory practices carried out by landlords, mortgage companies, and insurers are prohibited, so too law must prohibit discriminatory practices carried out by investors.We can do other things as well: for example, if we worry that big investors will capture local political processes, we can restrict the concentration of investment in a given locale.This points to another advantage of H2.0:where curtailing exclusion-minded homeowners has often proved politically difficult, regulating investors should be comparatively easy.

Finally, the subprime crisis should make us more interested, not less interested, in innovative adjustments to the mix of risks that homeowners accept.Protection against downside risk is likely to be of increasing interest to both homeowners and lenders, and tightening credit standards are likely to trigger new interest in the sale of upside potential as an affordability tool. And, while I've focused primarily on distant, diversified investors, the H2.0 model is sufficiently open-ended to accommodate local actors and institutions that would like to invest, quite literally, in their communities.

The Genetic Information Nondiscrimination Act, which bans certain types of genetic discrimination by employers and insurers, passed the House by a vote of 414 to one, and the Senate by a vote of 95 to zero. That means it's a good idea, right? Wrong.

Suppose an insurance company wants to offer a policy capped at $10,000 over a year. It has two types of potential clients: high-risk types who have a 0.05 risk of suffering a $10,000 injury and low-risk types who have a 0.01 risk of suffering a $10,000 injury. In expected terms, the high-risk types cost the insurer $500 each, and the low-risk types cost the insurer $100 each.

Consider the following question. If the insurance company can distinguish potential clients on the basis of easily visible markers (such as age), do you think it should be able to offer an expensive policy for high-risk types ($500) and a cheap policy for low-risk types ($100)?

Thanks so much, Rich, for these very insightful comments. In this first post, I'll take on your first two comments. I'll post later on your other points.

So why not just build a better leasehold? First, let me put labels aside and briefly cheer—if I've convinced you that there's a gap on the current tenure spectrum, that's much more than half the battle. Now let's consider what attributes that missing entry should have. I think we agree on at least two things: a long-term option to remain in the home at a fixed price, and tax advantages similar to those available to homeowners. If a tenure form is to provide consumption benefits that rival those of homeownership, it would also need to offer access to a wide array of housing choices (including plenty of single-family housing stock in good condition), and some reasonable measure of freedom with respect to matters like occupants, pets, and decorating. How to get there? First, we'd need Congress to remove the tax advantages for homeowners (I'm all in favor of that, by the way, as I've written elsewhere). That indispensable step probably already shifts us into the realm of the impossible. Still, let's forge ahead.

Next, we must get landlords to make available a lot more (and a lot better-maintained) rental housing than is presently available, with fewer restrictions on tenant behavior, and much, much, longer terms (even 30 or 40 years might be too short). Note that, as a practical matter, these long terms would have to be asymmetric—fully binding the landlord, but terminable on perhaps a half-year's notice by the tenant. It is difficult to imagine many landlords leaping to offer such deals. Of course, the law could force them to do it. But the law cannot force people to be landlords, and if the terms are unfavorable enough, landlords may stop landlording. Perhaps a system of subsidies could be developed to entice people into offering these idealized leaseholds. Still, serious moral hazard problems remain regarding the upkeep of the property (landlords will be tempted to shirk on factors that primarily affect consumption, while tenants will be tempted to shirk on factors that primarily affect the long-term value of the property). We can try to address these problems by letting tenants internalize the gains and losses associated with their own choices on the property and by giving them greater latitude to address on-site matters. But as we continue down that path, we begin to reach something very like H2.0, with landlords serving in place of investors. If a tenure form with these attributes sounds sensible as a matter of substance, scaling down traditional homeownership to generate it seems like a much more psychologically attractive and politically feasible approach.

I don't disagree with your second point, but I don't see how it's an argument against H2.0. Suppose onsite factors had absolutely no effect on the home's investment value or on the consumption value that residents could derive from living there (imagine all homes are identical, indestructible, self-cleaning stainless steel cubes). This would eliminate the moral hazard problems associated with leaseholds, and (tax issues aside) there would be no reason for the person who lived in the cube to also invest in the cube (because nothing she does to the cube will matter, either to her own comfort or to the cube's resale value). H2.0 merely translates that lesson to the messier world in which onsite actions do matter to some degree, by suggesting that the person who owns the rights to gains and losses associated with onsite activities need not also own the rights to the gains and losses associated with offsite occurrences.

I'll be back soon with more. Thanks again for giving me so much to think about!

May 05, 2008

Lee Fennell’s Homeownership 2.0 is provocative and deeply interesting—as with all her work, it is a pleasure to read. The idea that we could separate on-site and off-site factors in the home purchasing decision is attractive. For me, it is primarily attractive because it might reduce (in Lee’s language) “costly basket-guarding behaviors”: the homeowner’s extreme risk aversion to newcomers and the NIMBY(“not in my backyard”)ism that accompanies it. But I am skeptical that this proposal can get us there for a number of reasons:

First, why slice and dice homeownership when we have a form of tenure – the leasehold – that is better positioned to deal with on-site and off-site risk? I wasn’t quite persuaded that we shouldn't make renting a more robust form of ownership rather than making homeownership somewhat less robust. Why aren't renters the ideal since they only have the consumption interest in homeownership? I agree that homeownership has tax advantages and psychological ones, but my immediate reaction to the idea of bifurcating the risk in ownership is to encourage long-term leaseholds and give renters some of the tax benefits that owners currently enjoy.

Second, I wonder if off-site factors swamp on-site factors, conceptually. All houses are really bundles of off-site characteristics, i.e., location, location, location; the on-site amenities and maintenance mean almost zero if the house is located on the North Pole. These locational factors are huge, it seems to me—particularly if you factor in access to employment markets.

Third, I worry about giving absentee investors a stake in controlling off-site factors. Most investors will want a say in community governance, which introduces a lot of complications. What kind of pressure can these investors apply to local governments to adopt new zoning rules, deny development permits, prevent unwanted uses, or disfavor racially-heterogeneous neighborhoods? In an H2.0 regime, I'd predict increased neighborhood homogeneity as investors (like big developers) create standardized products while trying to limit their risk—investment money would flow to expanding white suburbs, the problem of redlining would reemerge under the guise of this new financial product. Perhaps Lee is betting that investors will be more rational than risk-averse homeowners, but I’m not persuaded. There is no reason to think that new H2.0 investors will operate any differently than the traditional investment partners of homeowners: banks and mortgage companies.

This leads me to my last comment. Perhaps, in light of the subprime mortgage debacle, this is not the time to create new fungible investment vehicles that will operate on a national scale. One could make the argument that the local savings and loan, investing in the local housing market, kept capital in the community and maintained the stability of neighborhoods (in part because the investors in the savings and loan often lived there). Coops and other forms of collectivized equity seem to try to recreate that community-investment link; it is interesting to note that Lee’s proposal tries to dilute that link.

May 02, 2008

Buying a home means accepting a
large dose of undiversified risk, much of it stemming from factors outside of
the purchased parcel and out of the homeowner’s personal control.
In this
article, forthcoming in the Northwestern
University Law Review, Chicago's Lee Fennell presents a
new tenure form, Homeownership 2.0 (“H2.0”), that reconfigures the default
homeownership bundle. Central to H2.0 is a distinction between
parcel-specific influences on home values, like remodeling and maintenance
choices (“onsite factors”), and influences on home values that emanate from
beyond the four corners of the parcel, such as neighborhood changes and larger
housing market trends (“offsite factors”). Fennell argues that investment
in onsite factors is essential to homeownership, but that requiring
homebuyers to invest in offsite factors as a matter of course is no more
sensible than forcing them to invest in some other random, localized venture
with variable returns. Indeed, scholars and innovators have already explored a
variety of ways to slice, dice, hedge, and trade housing market
risk. Using the H2.0 proposal as a focal point for analysis, Lee’s piece
steps back to examine how a reduced-risk version of homeownership would fit together
with property theory, human cognition, and the social dynamics of neighborhoods
and metropolitan areas.

Rich Schragger
of UVA School of Law will debate Lee’s paper next week on the Faculty
Blog. We hope you’ll join us!